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"It's going to get worse before it gets better"

Bunnings Harlow

Wesfarmers' new CEO Rob Scott told shareholders at their AGM in Perth yesterday, to expect the results from Bunnings UK and Ireland to get worse, before they get better.

This is the first time the incoming CEO has had an opportunity to comment on the poor performance of the business and manage investors expectations, as he warned the losses in 2018 would be even worse than those in 2017.

Homebase was bought by Wesfarmers for £340m in February 2016 and at the time committed to spending £500m on re-branding the Homebase estate to Bunnings, in addition to investing in stock-holding and staff. At the time of the acquisition, Wesfarmers said that the company first overseas investment would achieve an 18% return on capital within three to five years.  

Read - Sale of Homebase to Wesfarmers confirmed.

In August, Wesfarmers shocked the city, announcing that Bunnings United Kingdom and Ireland had lost £54m in its first full financial year of trading and at the time Richard Goyder then CEO, highlighted that Homebase would be loss-making for some time to come. 

Read - Losses escalate at Bunnings UK & Ireland.

Read - Homebase drags sales down at Bunnings UK&I.

In an effort to maintain the positive momentum achieved by the first trial stores, Scott went on to say "The customer and community response to the new Bunnings branded stores has been pleasing and they are delivering good sales growth. Losses are however expected to increase in the 2018 financial year as trading remains challenging for Homebase and as we progress the conversion from Homebase to Bunnings."

Mr Scott said the company would focus on improving BUKI's management team, and would "be disciplined with how we invest further capital". 

Michael Chaney Chairman of Wesfarmers said the company would be careful before investing any more money in the operations, highlighting that the losses were coming from the 242 Homebase stores, Mr Chaney said, while the 10 stores converted to the Bunnings brand were enjoying sales growth.

"I think it will be mid-next year before we get a good handle on how to roll these stores out – what sort of format, how different geographies and social economic areas vary – and how seasonality affects us," he told shareholders. "What we're doing is making sure as we go forward that we evaluate the capital we need to put in".

In a research note released to clients on Thursday, Bank of America Merrill Lynch analyst David Errington said that BUKI was shackled by meeting financial returns and would struggle to improve its business without investment. Same-store sales at BUKI fell 12 per cent in the first quarter compared to the same period last year. 

Analysis & Comment by Steve Collinge 

Mr Scott is in a really tricky position. New to the role and keen to ensure his reign starts well as only the eighth Wesfarmers CEO in 103 years and yet burdened with an acquisition made by his predecessor Richard Goyder and John Gillam, both of whom have now left the business.

If handled badly and if losses escalate, BUKI has the potential to not only derail the new CEO's tenure and put a serious question mark over his judgement, but this could impact negatively on the groups returns for some years to come. At this stage, he has no option other than to support the investment and decisions made prior to him taking over. But one thing we can be certain of, the company will already be evaluating the cost and implications of an exit before the situation gets much worse.

I've highlighted previously that Homebase has not been a particularly profitable business for many years. In the five years prior to the sale and when owned by Home Retail Group, the company couldn't make more than £50m profit on a turnover of £1.5bn. Since then, Wesfarmers have reduced retail prices by on average 20%, have exited softer ranges and abandoned the concessions, all of which contributed positively to the companys' profitability.

The Bunnings trials stores look great, with a very focused core DIY and garden offer and we have to believe Mr Scott, when he says they are achieving positive sales growth, but let's face it, it's not difficult to improve on the performance of a badly run Homebase store.

But even this sales growth comes at a massive cost. With a budget of almost £2m required to complete the transformation of each store from a Homebase to a Bunnings and with significant additional investment in stock and an almost doubling of staff numbers, it's unclear to me where the future profitability is ever going to come from.

What is clear from both the Homebase and Bunnings trial stores, is that significant efforts are being put into reducing the losses through better stock management and reducing staff costs. At the same time, retail prices are being increased across the board in Homebase and what was only a small percentage difference on pricing between the Homebase estate and the Bunnings trial stores 12 months ago, in some categories it's now running at between 10-15%. Yesterday I visited the trial store in Hemel Hempstead and noticed the cafe was closed. When I asked why, I was told the store didn't have enough staff to run it. If they are cutting back on staff across the board (which is what we're hearing from many sources), this impacts directly on the only area of competitive advantage that I believed Bunnings ever had over their competitors, customer service. 

Read - Cafe closes at Bunnings Hemel Hempstead

If I had to place a bet on the outcome - I'd say Mr Scott is correct, the situation will get worse, but however I look at it, I don't see how it's ever going to get better.

Source: Steve Collinge - MD Insight Retail Group Ltd

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17 November 2017

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